Drawdown investors need solutions focused on downside protection, inflation hedging and managing volatility risk
The sector has a job on its hands to ensure the pension freedom reforms so many of us celebrated just a few years ago do not become a landmark we reflect on with regret in decades to come.
That is the key message I took from the FCA’s retirement outcomes paper, which identifies a number of issues developing in the drawdown market.
The matters troubling the FCA are many and varied, ranging from a lack of education and awareness, to low engagement and too few people taking advice. The fact around a third of non-advised drawdown customers do not even know how their funds are invested just proves how crucial it is more people obtain professional advice.
Putting some of those issues aside for a moment, I want to explore the regulator’s concerns around investment solutions.
I was pleased to see it rightly identify product innovation has been limited since the pension freedoms. Because, while the Treasury has pressed ahead with a revolution in the pension tax system, manufacturers have struggled to respond accordingly.
There are very few investment solutions designed specifically to cater to clients in drawdown, despite the needs of these investors being so different to those in accumulation.
Instead of identifying a suitable investment solution, many retirees are placing their pot in cash, with around a third estimated to be in cash or near cash assets. Today’s retirees will find themselves at risk of eroding their spending power if they are unable to at least match price inflation, and that will not happen in cash.
In Australia, a market that introduced its own form of retirement freedoms in 1993, almost all retirees (94 per cent) are invested in what the regulator describes as “simple drawdown products” rather than annuities or any form of hybrid product.
The FCA notes that, in the UK, the development of products that combine drawdown along with guarantees remains niche, which is perhaps a good thing in a market where consumers value transparency and easy-to-understand products.
The regulator also raises concerns about the level of risk taken by retired investors. As the paper rightly notes, volatility is particularly important for drawdown consumers as they may rely on the income from their pot and so do not want its value to change too drastically.
While the normal ups and downs of the market present opportunities to buy assets you favour in accumulation, decumulation investors are at risk of eroding their capital if they are forced to sell the dip to generate income.
So, how can the investment industry use these findings to improve the outlook for retirees?
The prospect of hybrid products being developed and gaining traction appears slim. The Australian’s have struggled. Any guarantee is expensive to provide, requires scale that currently seems unachievable and often lacks transparency.
Accepting that, we must look to develop solutions that offer investment risk designed for clients in decumulation. That means products that manage the inflation and volatility risks that can be so threatening to retirement income funds in drawdown.
We cannot allow clients to continue sleepwalking into an inflation trap by holding cash. An individual that retired 25 years ago will have seen the cost of goods and services almost double in that time and today’s retirees will see their spending power diminished in a similar fashion if they are not able to hedge against inflation by investing in steady growth assets.
Investors must also be provided with access to solutions that recognise retirees will have a different relationship to risk to those in accumulation. We all know a portfolio that performs well in accumulation can be ravaged in decumulation. Investment managers must recalibrate their settings to deliver stable growth and minimise downside risk to protect client capital above all else.
We expect to see more investment managers deliver solutions designed for the decumulation market. The FCA has given notice that it expects to see change too. While it says it will give the market more time to develop, it will “consider the need to take further action on product innovation”. We have been warned.
Anthony Gillham is head of investment at Quilter Investors